- 10 Marks
Question
Economists are unanimous on the view that taxation is an essential tool for mobilizing
resources for economic development and in particular for a middle-income country such as
Ghana.
Required:
i) Describe briefly FIVE (5) purposes of taxation for an economy such as Ghana.
(5 marks)
ii) Explain the use and application of taxation as a tool of fiscal policy to stabilize the economy.
(5 marks)
Answer
The following are the main purposes or objectives of taxation in a developing economy:
1. Mobilization of Resources: The primary objective of taxation is to maximize savings by reducing consumption. Most of the tax revenues come from the rich through direct taxes.
2. Taxation as an Instrument of Economic Stability: Taxes are used to stabilize the economy by addressing instabilities caused by world market fluctuations, cyclical deficiencies in demand, and inflation.
3. Re-allocation of Resources: A tax system should minimally interfere with consumer and producer choices and ensure optimal allocation and use of productive resources.
4. Redistribution of Income and Wealth: Taxation helps reduce income inequalities by imposing taxes on the wealthy and using the proceeds for the benefit of the poor.
5. Economic Growth: Taxes are used to fund government activities and promote industries, trade, agriculture, and other sectors without upsetting the economy’s production, trade, and consumption patterns.
Taxation as an Instrument of Economic Stability
The under-developed countries are very susceptible to three sources of instability which result from the nature of their economy and the logic of accelerated economic development.
a) Instability caused by world market developments.
b) Instability due to cyclical deficiency of effective demand in the short run, and
c) Instability caused by inflationary pressures.
The under-developed countries are more vulnerable to the effects of international cyclical fluctuations due to the unbalanced nature of their economic structure and their heavy reliance on the export of primary products as a source of national income. This means that any fluctuations in the international demand for their products will tend to exercise a predominant effect on their national income through the medium of the foreign trade multiplier. Equally, as the under-developed countries export primarily raw materials, they import the finished manufactured goods from the developed countries, and in the event of an international recession, the under-developed countries exporting primary products find that the resources in agriculture and other primary industries are immobile in the short run and often continue to produce the same type and quantities of output as before. But as the demand for these products is inelastic, it leads to a fall in the prices of these products in the international market, leading to reduced export earnings which may affect the process of economic development in these countries adversely, as their own consumption requirements are very small due to subsistence living.
Specific fiscal instruments like export taxes are more useful as stabilization measures than aggregate fiscal instruments such as general sales tax and income tax. These specific tax measures are more flexible in adjustment than income tax and can also single out the export sector of the economy and counteract the destabilizing influences that arise from it. Besides, they are relatively simple to administer and difficult to evade. But the contribution of export taxes to internal economic stability, and thus, economic development, can be of great significance only if the under-developed countries are able to resist a high propensity to import consumer goods, especially luxuries, and have the necessary skill not only in the manipulation of export and import taxes but also in timing the changes and channeling the proceeds for promoting their economic development.
The stabilization objectives of taxation should also aim at maximizing the level of aggregate saving by applying a cut to the actual and potential consumption of the public at large. This stabilization objective should aim at curbing the conspicuous consumption of the rich and forcing them to save for capital formation, which, if maximized, should break economic stagnation and lead the country on the path of rapid economic growth.
Another objective of the stabilization policy of taxation should aim at protecting the economy of an under-developed country from the evils of inflation and depression, as the under-developed countries have unusual susceptibility to inflationary pressures. Stagnation is regarded as too heavy and unacceptable a price to pay for achieving stability in prices. At the same time, large-scale inflation as a means of promoting the economic development of the under-developed countries is beset with so many evils. Thus, the taxation policy for a developing economy should aim at curbing inflationary pressures inherent in a developing economy, as in such an economy, there is always an imbalance between the demand for and supply of real resources.
Equally, during a depression, taxation, along with other fiscal policy measures, must operate in coordination with each other to offset it. Thus, taxation policy, along with other fiscal policy measures, is ideally suited to check inflation and depression in a developing economy. Taxation will be reduced in deflationary situations, while during inflationary situations, taxation will be increased. If inflation is not controlled in time, it can undermine the very process of economic growth and development. As such, a suitable taxation policy for an under-developed country should be designed to curb inflationary and deflationary situations that can prove ruinous to an under-developed economy.
(5 marks well explained for 5 marks)
- Topic: Overview of the Ghanaian Tax System and Fiscal Policy
- Series: NOV 2019
- Uploader: Cheoli